Critical Pre-Selection Questions On Payroll Compliance

Testing Prospective Vendors’ Payroll Compliance Measures

Of the major advantages of either outsourcing payroll or managing it in-house with dedicated payroll software, perhaps the most salient is the easing of the compliance burden. As statutes both in the U.S. and internationally continually increase in complexity and become subject to much more stringent enforcement, the responsibility on the employer to securely store payroll data, submit the correct reports, and comply with national, state, and local regulations can be overwhelming. As ADP’s finance director Mike Ellis states "Certainly with the way things have moved you do need to be obsessed with compliance. There's going to be more and more regulation and more focus on control”. Indeed, aside from the inescapable fact that employees hold the organization accountable for payroll mistakes, the penalties and fines imposed by government agencies can be positively business-threatening. As such, it’s not surprising then that businesses of all sizes are looking to payroll software and 3rd-party payroll service providers for support with payroll compliance. However, in order to net the most out of these options, organizations must exercise due diligence in the payroll application selection process to ensure that compliance is well-handled. Here is our list of the key areas to focus on and questions to ask your prospective vendor.

An organization may wish to delegate its payroll compliance responsibilities, but in order to do so safely, it also must understand the responsibilities inherent with that delegation. Whatever country (or countries) the organization operates in, the selection process must ensure that the chosen payroll provider understands the statutory requirements. For example, the major pieces of U.S. labor legislation include:

The Federal Insurance Contributions Act (FICA), which covers Social Security, disability, and Medicare; places record-keeping responsibilities on employers; and impacts how wage and tax returns are handled for both the IRS and Social Security Administration.

The Federal Unemployment Tax Act (FUTA), which acts as a national umbrella to independently-managed state unemployment programs (again with record-keeping and reporting liabilities).

The FLSA (or Fair Labor Standards Act), which is the main U.S. legislation for minimum wage, overtime pay, equal pay and child labor and imposes highly-detailed recording requirements on employers for employees’ earnings, deductions and schedules.

The Consumer Credit Protection Act (CCPA), which contains specific provisions for the attachment of earnings and garnishments as well as a clearly delineated account of employers’ responsibilities.

However, these four legislative areas are simply the tip of the iceberg when it comes to local,
state, international and other federal provisions (e.g. COBRA, HIPAA, FLMA, etc.) for payroll
compliance. As such, companies should exercise caution and be aware of the rules and regulations
that apply to their organizations. After all, while delegation can ease the payroll compliance burden,
responsibility will still rest with the employer.

The U.S. Sarbanes-Oxley Act (SOX) was passed in the wake of the high-profile corporate financial scandals of the 1990s. Put simply, its aim was financial transparency for the protection of shareholders and investors. As payroll is one of the single largest financial operations for any business regardless of size, payroll management in both U.S. public companies and the companies they deal with must be in compliance. It is this last "companies they deal with” provision which takes the impact of Sarbanes-Oxley beyond U.S. borders. While no software can guarantee ‘SOX’ compliance by its functionality alone, both software designers and external payroll service providers should be taking the Act’s requirements into account in their offerings. The headline requirements of the Act are:

Financial statements should, "fairly present in all material respects the financial condition and results of operations of the issuer.” In other words, corporate officers must have the tools to monitor financial transactions, operations and approvals.

Adequate internal control structures and procedures, requiring proper security measures such as individual sign-ons and authorizations to create clear lines of accountability.

While detailed compliance questions can be formulated according to an organization’s specific requirements based on workforce composition, countries of operation and so forth, the potential service/software user would be wise to test a prospective payroll provider’s approach to some basic labor law issues, including:

The classification of workers as either employees or contractors, which makes a huge difference in deductions, reporting requirements and expense to the employer (unsurprisingly, the IRS closely focuses on the issue of misclassification).

U.S. social security contributions, which, while fairly straightforward to manage in the past, have added complexities via the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (areas where temporary adjustments have carried over into 2012 that require employers to keep track of differing employer and employee contribution rates).

Third party sick payments, which, though may be made via the appropriate insurance company, union plan, or state disability plan, the employer (via software or outsourced provider) is still liable for in regards to the usual W-2 return submittal.

These are just three examples of a number of “entry-level” labor law compliance issues of which a provider should be able to demonstrate an understanding.

Final Thoughts on Payroll Compliance Testing

Tight and rigorous legislative compliance for the payroll function is no “nice-to-have” capability. Rather, it is instead an absolute necessity for any organization, regardless of sector, size or scope. Quite simply, as an Aberdeen Group report highlighted, “Up to date compliance with relevant national and local labor laws avoids fines and legal action”. As such, when it comes to outsourcing payroll or procuring software to manage the function in-house, organizations must be completely satisfied with the absence of compliance risk—an endeavor that takes effort but will ultimately pay dividends.

While detailed compliance questions can be formulated according to an organization’s specific requirements based on workforce composition, countries of operation and so forth, the potential service/software user would be wise to test a prospective payroll provider’s approach to some basic labor law issues.